At its May meeting, the Federal Open Market Committee (FOMC) voted to leave the Federal funds rate unchanged at a target range of 5.25%-5.50%. The statement added a new sentence that acknowledged the recent stalling in the broad disinflationary trend, but also maintained the language the Committee does not anticipate it will cut rates until it is confident inflation is headed towards 2%.

Elsewhere, the statement noted that the Federal Reserve (Fed) will slow the pace of quantitative tightening (QT) beginning in June by reducing the monthly redemption cap on U.S. Treasury securities from $60bn to $25bn and maintaining the $35bn cap on agency mortgage-backed securities (MBS), though did not state when QT would end. The committee will reinvest securities maturing in excess of these caps into U.S. Treasuries.

The statement and press conference should not come as a surprise to investors. Recent Fed speech has acknowledged the lack of progress on inflation and the desire to maintain the current level of policy rates for longer. That said, it does seem clear the Committee remains biased to cut rates, but any policy easing will be determined by how inflation develops over the next few months. Indeed, since 1980, following a hiking cycle and prolonged pause, the Committee has never restarted rate hikes again, suggesting there is a very high bar to do so this time around.  

For investors, so long as the Fed remains biased to cut rates at some stage, we think risk assets can remain supported, particularly if consumption growth remains strong as tight labor markets and strong wage inflation support incomes. Indeed, it appears the Committee continues to believe the current level of policy rates is restrictive as evidenced by the cooling in labor demand. Moreover, bond markets have done a lot of the repricing already given current expectations for just one full rate cut this year, which seems reasonable.

Equities rallied and yields fell following the meeting, likely reflecting the firm cutting bias. We now expect the Committee will reduce rates 1-2 times this year, with risks skewed to fewer cuts. Investors should take solace in that growth remains strong, consumption is solid, and while inflation seems sticky, its not “sticking” at a level that is causing a surge in wages, eroding consumption, or lifting inflation expectations, comfortably putting stagflation fears to rest. Given this, investors should remain appropriately balanced across domestic and global equites and begin increasing duration exposure as restrictive policy guides the economy into a soft landing later this year and into next. 

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